In last week’s prediction for the week ahead my streak of good guesses came to an end. I had the temerity to suggest that market focus might finally be moving beyond the Fed policy/QE debate and turning to corporate earnings. While earnings provided some important stories, the biggest news came when the market ignored the slightly bearish Fed minutes and found comfort in a few words from Chairman Bernanke. While many of us saw nothing new, it is a matter of perception. I described the three schools of thought in this post. The trader school finally got the message this week, causing media types to conclude that he must have said something different or the markets would not be moving. Sheesh!

Is the Fed fixation finally behind us? In a week where Bernanke testifies before Congress, the Beige book comes out, and Fed Presidents are on the rubber-chicken circuit, this seems like a dangerous prediction. Undaunted, I will try again. This week’s key question will be all about new records in stocks and the lessons for corporate earnings reports. In particular, people will be asking:

Have we dodged the bullet?

Was the modest June swoon the extent of the market correction, or is there something else to fear? Ed Yardeni charts the corrections in the current bull market:

Here are three current viewpoints:

We are beyond the seasonal weakness in evidence during the last few years. Most see economic and earnings improvement in the second half of 2013. Brian Gilmartin reports that forward earnings are at a new record, year-over-year earnings growth is about 5%, and the earnings yield on the S&P 500 is 7.15% — all indicating a cheap market. He is expecting a new market record in the next few months. The top economic forecaster is looking for 3.25% growth in the second half of 2013.

Economic threats – the sequester, reduced home purchases due to rising rates, or effects from abroad – may derail the earnings story.Doug Kass is “very concerned” about earnings and pessimistic about the economic “false dawn.” He predicts that Q2 earnings will actually decline by 1%. This is a dramatic prediction with a near-term time frame.

We are OK for now, but political leaders in Europe and the U.S. have plenty of time before the year ends. The debt ceiling talks are on “life support” (via The Hill) and the debt ceiling must be raised this fall. Will it be a replay of 2011? Nothing bad actually happened from that debt ceiling debate, but consumer confidence plummeted as people watched the process. This week the political science world lost Alan Rosenthal of Rutgers, who studied the state legislatures of every state and helped to reform 35 of them. HisNew York Times obituary explains as follows:

“Observing the Ohio General Assembly, he decided to test the old saying that likened the legislative process to sausage making, so he visited a sausage factory. His conclusion, written for State Legislatures magazine in 2001, was that sausage making was cleaner, more efficient, more collaborative and better labeled.”

I have some thoughts on the potential for a market correction, which I will take up in the conclusion. First, let us do our regular update of last week’s news and data.

Background on “Weighing the Week Ahead”

There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.

My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topicthe week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.

This is unlike my other articles at “A Dash” where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.

It is better than expectations.

The Good

This was a light weak for economic news, but there were a few positive items.

A federal budget surplus? According to Karl Smith, the probability is increasing that we will see this in the next few years. I am scoring this as “good” since it reflects better revenues. Might it be happening too quickly? Scott Grannis sees the positive side:

“The bottom line is that the construction recovery is nowhere near ended. The building permits numbers point to a decent gain in housing starts in June (data out Wednesday). And with starts still well below historically normal levels, homebuilding volumes will keep rising for some time after that…”

European trade is achieving balance, proving the doomster’s wrong according to Olaf Storbeck at Breakingviews. He writes, “The latest German trade data confirm that one of the fundamental causes of the euro crisis may be fading away. The long-standing intra-euro zone trade and current account imbalances are disappearing slowly but surely. The progress is hidden behind the statistics’ headline numbers.”

The Bad

There was also a little bad news. Feel free to add in the comments anything you think I missed!

This week’s “ugly” award goes to the anonymous bond trader who moaned and groaned to CNBC’s Bob Pisani about Bernanke’s market moving comments in the Q and A following his long-scheduled speech to the NBER conference in Cambridge. Pisani repeatedly reported that traders were unhappy about this news and some on the network even described it as market manipulation.

These complaints illustrate a serious and important discrepancy between the reality of policy making and the reality of trading. I have been a member of both groups. As a trader, I never expected government actions, speeches, or data releases to conform to my trading convenience. The timing was announced in advance. It was up to me to decide if I wanted to carry a position overnight. I did not expect much from the Bernanke speech, and I was surprised that the market thought it was fresh news. The Fed minutes seemed more important. It was a surprise, just as like many other events.

Should Bernanke decline any speeches that are outside of market hours? Refuse to answer questions, even if repeating what he has already said before?

When you have a losing trade, you just accept it and move on.The Indicator Snapshot

It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:

For financial risk, the St. Louis Financial Stress Index.

An updated analysis of recession probability from key sources.

For market trends, the key measures from our “Felix” ETF model.

Financial Risk

The SLFSI reports with a one-week lag. This means that the reported values do not include last week’s market action. The SLFSI has recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a “warning range” that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

Recession Odds

I feature the C-Score, a weekly interpretation of the best recession indicator I found, Bob Dieli’s “aggregate spread.” I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50’s. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob’s information to improve investing. I hope to have that soon. Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration. Of special interest is the Leading SuperIndex, which accurately forecast the absence of a summer swoon. Since the weekly data are still mixed, it is important to monitor the index closely. Here is the most recent update and chart:

Georg Vrba’s four-input recession indicator is also benign. Here is his latest update where he concludes, “Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon.” Georg has other excellent indicators for stocks, bonds, and precious metals atiMarketSignals.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now over 18 months old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our “Felix” model is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. Two weeks ago we switched to a bearish position, but it was a close call. Last week we switched back to neutral, which was also a close call. The inverse ETFs were more highly rated than positive sectors by a small margin, but remained in the penalty box. This week we are almost in bullish territory. This has been an amazing change in only two weeks. I will stick with “neutral” for this week, but the bias is to the upside.

These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix’s ratings have improved a bit. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I’ll do my best to answer.]

The Week Ahead

There is a lot of news and data on this week’s calendar.

The “A List” includes the following:

Bernanke testimony (W-Th). The semi-annual report to Congress spans two days. This time he starts in front of the House Financial Services Committee and then presents exactly the same statement the next day to the Senate Banking Committee. Next time the order will be reversed. The feature of both sessions will be questions from our legislators. While I do not expect any new information, traders seem to

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

Housing starts and building permits (W). Housing may now be the most important economic driver and building permits are the best leading indicator.

Retail sales (M). An important confirmation of other data on consumers.

The “B List” includes the following:

Industrial production (T). Especially important for those few who still fear an imminent recession.

Beige book (W). The Fed’s collection of anecdotal evidence will be in front of the participants at the next FOMC meeting, so it could be interesting. The various regions take turns in preparing this material.

Leading indicators (Th). Still a favorite of many, and showing only a modest positive.

CPI (T). This will be influenced by energy prices, while the core remains subdued. This is not really a factor at the moment, but it bears watching.

There is plenty of other news, including Chinese economic data on Monday, various speeches by Fed bank presidents, and the regional Empire State and Philly Fed releases. Any of these might move the markets if unusual.

And most importantly – more earnings!

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued a neutral posture in equities. We have had a successful long position in oil (via USO) and a one-day foray into the inverse ETF for the DJIA (DOG). DOG went back to the penalty box – or should I say the doghouse – after only one day! Like any human trader, Felix makes mistakes. The overall ratings are now slightly positive, so we may see some new positions this week. It is fair to say that Felix remains cautious about the next few weeks. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens. More recently, Felix has avoided the treacherous stock trading of the last few weeks while making some profit in short bonds and long oil.

Insight for Investors

This is a time of danger for investors who are stubbornly sticking to losing ideas. My recent themes are still quite valid. If you have not followed the links below, please find a little time to give yourself a checkup. You can follow the steps below:

What NOT to do

Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. It has already started. Check out Georg Vrba’s bond model, which continues to signal the risk. Other yield-based investments have also suffered, and it is not over. Check out the latest interest rate forecast from LearnBonds. Or the timetable to a 4% ten-year note from Goldman Sachs (via Joe Weisenthal).

Find a safer source of yield: Take what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. I have had a number of questions about this suggestion, so I recently wrote an update. That post provides background as well as concrete examples showing how you can try this strategy yourself. There is nothing quite as satisfying as watching your account grow while the market is doing nothing or trading in a range.

Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on news events and not enough on earnings and value. You need to understand and accept normal market volatility, as I explain in this post: Should Investors be Scared Witless?

Get Started

Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. Recent weeks have been tough for traders. Most were surprised by the market reaction to more FedSpeak and the spike in interest rates.

For investors it was a different story. If you had your shopping list, there have been good opportunities to buy stocks. For those following our enhanced yield approach you had both the chance to set new positions and to sell calls against old ones.

And finally, we have collected some of our recent recommendations in a new investor resource page — a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).

Final Thought

There is always the potential for a market correction. We know that corrections will occur even during the best of years.

The biggest challenge for the intelligent investor is the flow of news. There is always something to worry about. Smart people try to draw conclusions about anything that might be a threat. Every week I get calls from new clients – very intelligent, well-educated people who have been successful in their day jobs. When they tried to apply these skills to their own investments, something went seriously awry.

The biggest single reason is a failure of perspective. Instead of trying to explain, let me highlight the best investment article from last week, Josh Brown’s Why the Long Bias? He writes as follows:

“It’s very simple.

Optimism as a Default Setting is the only way to successfully fund a retirement over the long stretch. Unless you believe that you have the god-like ability to dance into and out of the markets with good timing on a consistent basis. I know you can’t and I don’t even know you.

Fun fact – pick any day of any month of any year over the last 50 years – if you bought the stock market on that date, you had a 75% of being up one year later. That’s the math of being in the game and being long-biased at all times.”

Most importantly, few investors should be “all out.” Look at a chart – stocks, GDP, population, profits, number of homes, number of computers — you name it. Things improve. That should be the “default setting.” You can adjust your defaults by looking for risks as we do each week in this series.

Insist on quantification. There are always worries. For perspective, compare your own current list with those when the Dow was at 10K – Dow 20K and the Wall of Worry.

What I recommend is in sharp contrast to the various sources telling investors that stocks are too expensive. Those who unwisely use, for example, the Shiller CAPE ratio for market timing have a short bias as their default setting. Prof. Shiller himself does not take this approach, although many of those citing him draw that conclusion. See the full story here.